Opinion: Why British interest rates will never go up again

The Bank of England's official bank rate has been at 0.5% for five years. Will it ever rise?

By

MatthewLynn

LONDON (MarketWatch) — The autumn of 2014? Er, scratch that. The spring of 2015? Put that on the back burner. How about the autumn of 2015? For the moment, that seems to be the consensus.

The markets have had plenty of dates that they penciled in for the first rate rise from the Bank of England. But each time one of them actually comes close, something comes along to blow it off course.

The trouble is, the right moment never seems to arrive.

It happened again this month. Analysts and economists in the City of London were confidently expecting the first rise sometime in the spring of next year. Then the plunge in the global markets of early October, combined with some disappointing economic data, meant that timetable was hurriedly reset.

Here’s what is actually going to happen. Interest rates in the U.K. may not ever go up from the near-zero level of the last few years. Japan cut its rates to those levels more than two decades ago and it is no closer to a rate rise now than it was in the mid-1990s. Sooner or later the penny is going to drop that rates are not going to go up, at least not in the working lives of most people in the market today.

The timetable for the Bank of England to start moving interest rates back to normal levels is about as reliable as an Italian train. When Gov. Mark Carney moved from Canada to the U.K., he bought with him a policy of forward guidance, which was meant to give companies and consumers a clearer idea of where interest rates were heading. He set out criteria such as falling unemployment, and rising real wages, that would need to be met. But once those targets were hit, rates would start going up again.

There was certainly a lot to be said for that. It was on March 5, 2009, that the bank cut interest rates all the way down to 0.5%. At the time, it was presented as an emergency measure, designed to cope with deep recession bought on by the near collapse of the financial system a few months earlier.

It was not presented as a normal rate, nor, at the time, is it likely that many of the members of the Monetary Policy Committee saw it that way either. They thought rates would stay at that level for a year or two, and then start to edge their way back towards normal.

The trouble is, the right moment never seems to arrive. Despite heavy signaling through last spring that a rate rise was likely before the end of 2014, it hasn’t happened.

In fairness, there are plenty of good reasons for postponing it.

The U.K. might have been one of the fastest-growing developed economies over the past year, but right now all the signs point towards a slowdown. Mortgage lending has stalled, suggesting that the minor boom in house prices is about to run out of steam. Growth of gross domestic product slowed to 0.7% in the third quarter from 0.9% in the second. Exports to the struggling eurozone are failing to make any headway. Inflation has dropped to 1.2%, well below the bank’s target of 2%, and the U.K. is now clearly importing deflation from its neighbors across the English Channel.

The only strong number right now is employment growth, and that is to be welcomed, but since most of those jobs are poorly paid, and real wages are still falling, that is only a cause for a very modest celebration. Against that backdrop, it was very hard to make a case for putting rates up this month, or indeed next spring. It is hardly surprising that the idea had been kicked out to next autumn.

Five years of near-zero rates are already stretching to six, and may well soon get to seven.

But who is to say that will be the right moment either? A year is a long way away. The eurozone may be going through a fresh crisis. The stock market might have collapsed. The U.S. recovery might have stalled. All kinds of things could postpone a rate rise. It may well get rescheduled to 2016. And after that to 2017.

Which country does that remind you off? Japan. All the way back in September 1995, Japan cut rates to 0.5%, as part of an emergency package of measures to try and stop its lurch into deflation. It was the lowest rate in Japanese history. Since then, they have only come down further, although at those low levels it does not make much difference. There is no longer any suggestion that they are going to go up again.

What makes anyone think the U.K. will be any different? Japan did not plan to have permanent near-zero rates. It is just that its economy was never strong enough to withstand a rise.

Five years of near-zero rates are already stretching to six, and may well soon get to seven.

At a certain point, they become entrenched in the system. Most borrowers will have taken out their mortgages at those very low rates. If they start to rise, they will be in deep financial trouble. Likewise, companies and indeed the government, have become used to paying very little interest.

Keep in mind that the U.K. is one of the most indebted countries in the world, with total corporate, personal and government debts of more than 500% of GDP, according to McKinsey research. Only the Japanese owe more.

The U.K. can probably withstand some minor rate hikes. But the very high levels of debt will always mean there is a better case for postponing them.

The bank could have raised rates last spring. It decided not to. There were plenty of good reasons for that decision. But it may well have meant that rates never go up again. The markets are still spending a lot of time speculating about when rates will go up. Sterling
GBPUSD, -0.4752%
bounces around as the consensus ebbs and flows. Eventually everyone is going to realize they are not going to go up — not this year, next year, or anytime in the foreseeable future.

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